At the 2013 Society of Trusts and Estates Practitioners (STEP) Conference, there was a review of the law and the positions of CRA regarding gifts to registered charities by Will or by trusts, and the technical rules and complications that arise when charities are recipients of such gifts where corporate shares are involved. Case studies were reviewed to illustrate certain technical issues and planning points.
The session emphasized the importance of donors determining where the donation tax credit is best utilized – i.e., in the donor’s terminal return or the trust return filed by the estate. The goal is to avoid having the tax liability in one tax return and the donation credit in the other or, worse yet, not being able to use the donation tax credit in either return.
For many donors, it is important that the donation tax credit is available to be used in the donor’s terminal tax return. To achieve this result, the gift must qualify as a “gift by Will” under Section 118.1(5) of the Income Tax Act.
As there is very little case law on what constitutes “a gift by Will”, it is necessary to look at the various CRA positions and guidelines. The wording of the Will is critical. Section 118.1(5) will generally be considered to apply where (a) the terms of the Will provide for a donation of a specific property, a specific amount or a percentage of the residue, (b) it is clear from the Will terms that the executors are required to make the gift, (c) the estate is able to complete the gift after payment of debts, and (d) the gift is actually made.
CRA’s rules on what will qualify as a gift by Will are quite strict. Note that subsection 118.1(5) is not elective – if a gift meets the conditions as set out above, it will qualify as a gift by Will and the donation tax credit can only be claimed on the terminal return.
It is clear that if the amount of the gift is left to the executor’s discretion, it will not qualify as a gift by Will. However, while the amount cannot be left to the executor’s discretion, CRA has indicated that the gift will qualify as a gift by Will under the following circumstances:
- where a defined amount is left to a number of charities but the executor has the discretion to set the allocation; or
- where a defined amount is left to charity but the executor has the discretion to select the charity; or
- where a defined amount is left to a private foundation to be established by the executor as instructed in the terms of the Will.
This does allow for final selection of charities or allocation of a specified amount among them by the executor after the donor’s death.
It has also been decided that if a Will establishes a testamentary trust and a charity is the remainder beneficiary of the trust, the gift to the charity could still be a gift by Will if the personal representative has no discretion to encroach on capital. The gift by Will is valued by calculating the present value of the residual interests taking into account the fair market value, life expectancy of the life tenant and current interest rates.
Even where a Will establishes a testamentary trust and there are encroachment rights, it may be preferable to have the gift qualify as a gift by Will so the donation receipt can be used in the terminal return. In this circumstance, if there has been no encroachment on capital, it may still be possible to have the life tenant execute an irrevocable disclaimer with respect to capital that will enable the gift to qualify as a gift by Will.
It is also the CRA’s view that where an individual’s Will directs an executor to donate an amount to a charity to bring the amount of income tax liability on the deceased’s final return to zero, the donation will generally qualify as a gift by Will.
However, a gift will not be a gift by Will if the executor has discretion as to the amount or discretion as to whether or not to make the gift.
If it is important for the donation tax credit to be claimed in the trust return, only where the trustees are empowered to make gifts at their sole discretion will the trust be entitled to claim the donation tax credit. If the trust document simply directs the payment of amounts to a charity, the distribution will be viewed as a distribution to a beneficiary and not as a donation entitling the trust to a donation tax credit. The trustee must have the right to decide whether to make gifts to a charity and in those circumstances, the document should describe the charity as a “gift recipient”, rather than a beneficiary.
One must be very careful in making charitable gifts where the estate holds corporate shares. Where there are corporate shares, there is often planning to avoid double tax, first on the gain realized on death (the deemed disposition) and secondly, when the underlying assets of the corporation are sold and the proceeds distributed. There is often some kind of plan to avoid this double tax, all of which often occurs within the first year after death.
The STEP session also highlighted a technical problem which can arise where a private foundation is a beneficiary under a Will where the estate includes corporate shares. The Act provides for a divestment obligation if a private foundation and persons related to the foundation together hold more than a certain percentage (20%) of any class of shares. For the purpose of determining the divestment obligation, if a person, including a private foundation, has an interest in a trust that holds private company shares, that person may be deemed to hold the shares.
Accordingly, even though the private foundation has no control over divestment of the shares and may not even be a beneficiary of the shares at the end of the day, the private foundation may still have a divestment obligation related to shares which it does not control or to which it has no entitlement.
It is important to keep these rules in mind when drafting Wills and trusts, so as to ensure that the available charitable tax credits are maximized and used optimally in the terminal return and/or the trust return of the estate.